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Wednesday, September 5, 2018

Nuvo Gets Old

I generally stay away from pharma companies, because it's hard to predict what they are going to earn a few years out. What they earn right now could go up in smoke when the patent expires, and what they have spent in R&D could turn out to be totally worthless. This makes it very difficult to estimate any kind of margin of safety, which is a key component to anything I invest in.

But I believe I had found an exception in Nuvo Pharmaceuticals (NRI). This was essentially a one-drug company. It was profitable, debt-free and the main drug's patents extended out into the late 2020s. To the extent it spent on R&D, it was mostly towards increasing penetration of the drug to new geographies. Nuvo even had manufacturing capacity such that it could utilize its own facilities to produce similar classes of drugs. Along those lines, it made an acquisition with the intention to eventually bring production of the target's anti-lice cream in-house.

Nuvo traded at about 5-7 times what I anticipated to be their normalized free cash flows, at least until the patents expired. But then everything changed. Last month, the company announced they were in talks to buy the assets of a bankrupt firm. These assets generate 3x the revenue of Nuvo, requiring the company to go deep into debt. What seemed like a great bargain is now going to a situation which is very difficult to evaluate.

Could I have seen this coming? Maybe. Though the company seemed to be acting prudent and growing slowly, management does not own a significant amount of shares. This gives them the incentive to focus on growth rather than profits, which is my preference.

As a result, I've sold my shares at a loss. Maybe it works out for shareholders, but it's too unpredictable for me now. I suspect it would have worked out well without this acquisition, but I guess we'll never know.